Strong Hiring Figures Send a False Signal
Despite bullish job numbers, we could still be headed for a recession.
Economists, politicians, and commentators have been debating recession since early 2022, when the first quarter’s real gross domestic product (GDP) report showed a decline. Those pointing to weakness in the economy, whether for political or analytical reasons, declared recession when the second quarter also showed a decline. Two quarters of decline is, after all, the rule of thumb used to identify recessions. Those who believed that the economy was in good shape, whether for political or other reasons, argued technicalities at the time. But now that many indicators have begun to offer additional signs of economic weakness, the optimists are pointing to still-robust rates of hiring as a reason why the economy will avoid recession this year. They look for a “soft landing” in 2023, by which they mean an adjustment, not a recession.
Anything is possible, of course, but the jobs growth of recent months is a dubious signal at best. Rather than a sign of fundamental strength, continued robust hiring in this environment looks increasingly like a kind of labor hoarding that will require a recessionary adjustment—and soon.
On the surface, the jobs numbers certainly look encouraging. In December 2022, for instance, the Labor Department’s popular Employment Situation Summary report quoted its employer survey to declare an impressive 223,000–job gain over October’s level. A separate survey of households was still more impressive, recording an employment gain of 717,000. While these and other recent hiring measures fall short of monthly employment gains recorded in 2021 and the first half of 2022, they nevertheless exceed broad historical averages by a wide margin. With data like these, it’s easy to see why many conclude that, contrary to preparing for recession, businesses are likely building up staffing to get ready for a major production expansion.
Nonetheless, many other data points call into question the optimism occasioned by these hiring figures. Consumers, for instance, have cut back on their spending. Retail sales have shown flat-to-negative real growth in recent months, a sharp correction from the great strength they showed in 2021 and early in 2022. New home purchases are running 15 percent below the rates from a year ago. The rate of new home construction is down 30 percent over the same period. Business spending on equipment and intellectual property has held up, but spending on new facilities has been in decline for some time, suggesting that the funds are flowing into efficiency and labor substitution rather than a general expansion. Even then, the pace of increase in business investment spending has slowed markedly from 2021 and earlier last year.
The seeming contradiction between these two different sources of economic information—the jobs figures on the one hand and the spending figures on the other—begs an explanation. Fortunately, one emerges from another Labor Department report: the quarterly look at worker productivity. The picture offered there suggests that the recent jobs growth, far from being a sign of economic strength, is part of a distorting trend and cannot last long, and that this year we will see layoffs, or at the very least a sharp decline in the pace of hiring.
What these figures make clear is that businesses are not using their new employees much at all. Robust hiring has, of course, resulted in a strong 3 percent annual increase in hours worked over the first three quarters of 2022, the most recent period over which data are available. But it also shows that, for all these additional man and woman hours, output has hardly expanded at all, growing at a 0.2 percent annual rate during these three quarters. Productivity—that is, output per hour worked—has accordingly plummeted during this time, falling at a 3.1 percent annual rate.
This combination of facts implies that businesses, instead of staffing in anticipation of increased production, are hoarding labor. The impulse to do so is certainly understandable, given the labor shortages that afflicted the country in 2021 and early 2022. Memories of that experience are surely enough to prompt managers to hire qualified labor even in the absence of an immediate staffing need. Those memories would also make managers more reluctant to cut back on staff, even in the face of falling levels of production. No employer wants to go through the expense and bad feelings of layoffs under any circumstances, but businesses especially want to avoid it when facing the threat of being caught short staffed, as was the case not too many months ago.
The odds of a demand surge to justify all this excess staffing look slim. The consumer-spending slowdown reflects the ill effects of inflation on the buying power of household incomes. That problem is not likely to be resolved soon. At the same time, further interest-rate increases contemplated by the Federal Reserve seem certain to apply continued downward pressure on homebuying and homebuilding, at least for some months to come. Business, in other words, is not likely to see the sudden pickup that might justify holding excess staff on payrolls now.
Rather than signaling a “soft landing,” this picture suggests that staffing adjustments are overdue. Business cannot remain profitable and sustain idle or underutilized employees for long. With hourly compensation for these workers on the rise at an almost 3 percent annual rate, the cost of producing a unit of output (what the statisticians refer to as “unit labor costs”) has been rising at a 6 percent annual rate. This fact points to continued pressure to raise prices into 2023. More critically, it also underscores an urgent need for businesses to revisit their staffing practices—they should become less willing to emulate the technology and financial sectors in hoarding new hires, only to be forced later to turn to layoffs.
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